Economic Backdrop to Budget 2018

The economic background against which Budget 2018 was presented is positive. The global economy continues to expand and most domestic economic indicators are continuing to suggest solid growth in the economy.

We only have detailed national accounts data for the first half of the year. Despite the distortions created by the multi-national sector, the underlying picture is good. In the first 6 months, gross domestic product (GDP) expanded 5.5% and gross national product (GNP) expanded by 2.6%. Consumer spending on goods and services increased by 1.7%; investment expanded by 3.1%; exports of goods & services expanded by 3.2%; and imports of goods & services declined by 1.9%.

The following is a synopsis of the most up to date data:

In the first 8 months of the year, the value of retail sales increased by 1% and volume of sales increased by 3.3%. However, weak new car sales have distorted these figures. When car sales are excluded, the value of retail sales increased by 3.6% and the volume of sales by 6.6%. The persistent gap between the value and volume metrics is indicative of a consumer sector that is still resistant to higher prices, but the trend in retail spending continues to improve;

New car sales declined by just over 10% in the first 9 months of the year. Sterling weakness and high motor-related taxes are leading to a surge in imports of second hand cars from the UK, and these imports are undermining new car sales;

The labour market is performing very strongly. Employment increased by 48,100 or 2.4% in the year to the end of June 2017. Employment in the second quarter stood at 2.063 million. The sectoral breakdown of employment growth is strong. The overall increase in employment was made up of a very strong increase of 77,800 or 5% in full-time employment and a decline of 29,700 (-6.7%) in part-time employment. The latter changes are really indicative of the strength of the overall labour market and the improving confidence of the business community;

The unemployment rate stood at 6.1% of the labour force in September, down from 15.2% in 2012. The seasonally adjusted number of people unemployed stood at 133,200 in August and has declined by 63,600 over the past two years;

The export sector of the economy is performing strongly. In the first seven months of the year, the value of merchandise exports was 6.7% ahead of the same period in 2016. Exports of food and live animals increased by 15.9%. Somewhat surprisingly given the weakness of sterling, exports to the UK increased by 12.6%. It is probably the case that Irish exporters to the UK are using price to maintain competitiveness in the face of very adverse exchange rate movements. This would have negative implications for business margins and would not be a sustainable situation for business in the longer-run;

The tourism performance continues to be very strong. In the first eight months of the year, the number of overseas visitors to Ireland was 2.5% ahead of the same period in 2016. However, visitor numbers from Great Britain were 7.1% lower. Visitors from Great Britain accounted for 37% of total overseas visitors to Ireland in the first eight months of 2017. This is down from 41% in 2016. Sterling weakness is pressurising this market; and

Consumer confidence was at an 18-month high in September.

Budget 2018 – The Economic and Financial Assumptions

The success or failure of any budget in terms of its fiscal targets is heavily dependent on how the real economy performs.

Table 1 provides a summary of the economic outlook according to the Department of Finance following the changes announced in Budget 2018.

GDP growth is expected to average 3.5% per annum between 2017 and 2020.

Table 1: Economic Forecast

Table 2 shows the projections for the key budgetary numbers out to 2020.

Table 2: Fiscal Forecasts

Key Challenges in Budget 2018

While the Irish economy continues to enjoy strong and broad-based growth, it is clear that there are significant challenges ahead. It was essential that Budget 2018 should be heavily driven by these challenges.

The key challenges include:

The personal tax burden is very onerous;

The quality of public services is seriously deficient, with the health sector under particular pressure;

There is a significant shortage of owner-occupied housing, social housing and rental property. This is manifesting itself in rapid growth in house prices; rapid growth in private rents; and a serious homelessness problem;

Sterling weakness is threatening the competitiveness of Irish indigenous exporters and tourist numbers from the UK;

Brexit is creating massive uncertainty for the Irish economy and poses a potentially immense challenge for the indigenous Irish economy, but also poses considerable potential opportunities as UK companies locate in an EU jurisdiction.

It was vital that Budget 2018 should be framed in a manner that will help address and alleviate these challenges. The most important priority is to ensure that the competitiveness of the economy is maintained; that the tax system rewards work and improves incentives in the economy; that the SME sector is encouraged and supported; and that those who take economic risks are rewarded appropriately. Having a strong sustainable economy is the key to addressing the various challenges and risks facing the economy. Economic activity generates the resources that funds all government expenditure, including the provision of public services and social protection.

Key Elements in Budget 2018

The Irish Fiscal Advisory Council (IFAC) recently suggested that the Minister for Finance would have an extra €1.7 billion at his disposal on budget day, assuming he sticks to his expenditure commitments as laid down by the EU. Of this €1.7 billion, the carry over effect of previously announced measures and the yet-to-be approved public sector pay increases would use up around €1.2 billion. This would limit the budgetary scope to around €500 million, which in the context of the magnitude of overall expenditure and revenues, is a small amount of money.

However, in the Budget he increased the available fiscal space by increasing the economic forecast for 2018, which is realistic, and also through tax raising measures totalling €830 million.

In the event, Budget 2018 contained an expansionary package worth €1.233 billion. Of this expenditure measures accounted for €898 million or 72.8 % and the tax giveaway measures totalled a net €335 million, or 27.2% of the total fiscal expansion.

On the taxation side, the key measures in Budget 2018 include:

The threshold at which workers end up paying the top rate of tax was lifted by €750 to €34,550 for a single worker and to €43,550 for married one-earner couple. This is estimated to cost €152 million in a full year;

The Home Carer Tax Credit was lifted by €100 to €1,200;

The Earned Income Tax Credit for self-employed has been increased from €950 to just €1,150. For employees, it stands at €1,650, so self-employed tax payers are still being discriminated against, but progress is being made. This is important in the context of the Brexit challenges faced by the SME sector. This is estimated to cost €31 million in a full year.

The 5% USC rate was cut by 0.25% and the 2.5% rate was cut by 0.5%. The 2.5% rate was paid on incomes between €12,200 and €18,772 and this ceiling is being lifted to €19,372. The cut in this rate will benefit lower income earners disproportionately. These measures are expected to cost €206 million in a full year. The effect is that the marginal rate of tax on incomes up to €70,044 has reduced to 48.75% from 49%;

The stamp duty rate on non-residential property transactions was increased from 2% to 6%. This measure will hit funds investing in commercial property and will have cost implications for pension funds, amongst others. It applies from midnight on budget night. This measure is expected to raise €400 million in a full year;

A sugar tax on sweetened beverages will be introduced on April 1st 2018;

Capital allowances on intangible assets will be reduced to 80%, which will mainly affect multi-nationals moving intangible assets such as intellectual property into the country. This measure is expected to raise €150 million in a full year;

The benefit-in-kind rate on electric cars will be 0% in 2018;

The 7-year period owners must retain qualifying assets, mainly property assets, to enjoy full relief from capital gains tax (CGT) has been reduced to 4 years. This is a sensible move to bring property on to the market;

The price of a packet of 20 cigarettes will be increased by 50 cent. This is expected to raise €64 million.

On the expenditure side:

Total government spending in 2018 is projected at €60.9 billion, with current spending accounting for 91.3% of the total and capital spending for 8.7%.

Gross current government spending in 2017 is expected to be 3% higher than in 2017 and capital expenditure is projected to increase by 17.4%, giving an overall increase of 4.1%. or €2.4 billion.

Social welfare payments, including old age pension will increase by €5 per week.

On the housing side:

I believed at the time of its introduction that the ‘Help to Buy’ scheme was a mistake as putting more money into the hands of buyers would only fuel demand and would have only one outcome. That has turned out to be the case. However, we are where we are, and to abolish the scheme now would only have created more distortion in the market. Hence, it was not touched in Budget 2018, although a review of the scheme was published.

Michael Noonan previously introduced mortgage interest relief for people who were unfortunate enough to buy houses between 2004 and 2012 which was due to expire at the end of 2017. This is being extended out to 2020, but will be tapered from 75% in 2018; 50% in 2019; and 25% in 2020. This is good news for some hurting mortgage holders.

Addressing the supply side of the housing market crisis is much more effective than addressing the demand side. This is where the key focus of Budget 2018 is. The Minister has allocated €1.83 bln to housing in 2018. This is a significant amount of money and will be primarily directed at delivering social housing. The ability to deliver on the social housing targets will not be easy, given the capacity constraints in the construction sector.

On the private housing supply side, a number of important measures were introduced. The Ireland Strategic Investment Fund (ISIF) will allocate €750 million to a new housing finance agency, which will be called Home Building Finance Ireland (HBFI). This mechanism will be designed to provide funding for development purposes for developers to deliver housing supply. One of the many problems facing many developers is inability to raise finance at a competitive cost to develop. This initiative should go some way towards addressing this issue. Alongside this initiative, the Vacant Site Levey is being increased from 3% in year 1 to 7% in year 2 and subsequent years. In other words, if developers or others are hoarding land, there will be a punitive tax applied. This should give a strong incentive for developers to develop sites as quickly as possible, and with the possibility of funding being available from the HBFI, we should see more private residential supply coming on stream.

On the rental side, the budget contained one main measure. In order to encourage owners of vacant residential property to bring that property into the rental market for a minimum of 4 years, a new, time-limited deduction for pre-letting expenses is being introduced.

Accepting that the world cannot be changed in just one budget, the efforts made by the Minister in boosting the supply of social housing and private housing has to be acknowledged. The big challenge is if we have enough capacity on the construction side to deliver the planned housing.

Conclusions

There was no major surprises in the Budget as it had been well leaked in advance. The attempts to ease the burden on middle-income tax payers are modest, but at least moving in the right direction. The strong focus on expenditure in the budget package will see a significant increase in current and capital spending. Health, housing and education are the key target areas for expenditure increases. These reflect a sensible set of priorities.

The economic assumptions underlying the budget look very realistic and suggest that as long as there are no unforeseen shocks, the economic outlook looks positive for the foreseeable future and the public finances will continue to improve.

All in all, it looks like a reasonably good day’s work for the Minister for Finance, given the very limited resources at his disposal. Incremental changes are being introduced, and provided they remain on track, the benefits will gradually be felt over the coming years. Of course, regardless of what the Minister did in the budget, he was never going to please everybody. That is the reality of political life and scarce economic resources.